Yields on TIPS Go Negative

A combination of low interest rates and growing fears of rising prices enabled the U.S. government to sell inflation-protected Treasury bonds with a negative yield for the first time ever on Monday.

That means if inflation doesn't appear as investors expect, they could end up paying to lend money to the government.

ENLARGE

The Treasury sold $10 billion of five-year Treasury inflation protected securities, or TIPS, at an auction on Monday with a yield of negative 0.55%.

The big demand is a sign the Federal Reserve is gaining some traction in its efforts to kickstart the economy and nudge inflation higher. TIPS are designed to protect investors against inflation, offering a return that rises as the cost of goods increase. In times of inflation, they are more attractive than standard Treasury bonds, whose fixed income stream is worth less as other prices are rising.

"While the yield on many TIPS is negative, investors in these securities expect a positive return overall,"
Tony Crescenzi,
portfolio manager at Pacific Investment Management Co. in Newport Beach, Calif.

Financial-market investors, economists and even Federal Reserve officials have been engaged in a months-long debate over whether inflation or deflation is the bigger threat to the economy. In some ways, Monday's auction is a sign that some investors are tilting in favor of inflation. There are other signs, too. Gold, a traditional hedge against inflation, is trading near record highs and the U.S. dollar has been falling.

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TIPS investors won't lose money as long as the economy avoids deflation for the next five years, because TIPS investors get extra money every year to keep up with the inflation rate. If inflation is high enough to offset the negative yield, investors will end up with a positive return.

Yields on Treasury bonds have turned negative before, particularly at the depth of the financial crisis. Then, investors in short-term Treasurys did pay a small amount of money to lend to the government, but were willing to do so because they were able to protect most of their investment from market turmoil.

Today's extraordinarily low yields are a result of Fed efforts to fend off deflation by buying up Treasurys and TIPS to push their yields to rock-bottom levels. Investors expect the Fed to announce another round of Treasury purchases after its policy meeting on Nov. 3. Investors have been buying both TIPS and Treasurys in anticipation, but lately TIPS have outperformed.

If negative TIPS yields reflect anxiety about inflation, then that suggests the Fed may be succeeding. Deflation is partly a result of consumers delaying purchases because they think prices are going to fall.

The negative yield on five-year TIPS owes partly to the fact that nominal five-year Treasurys yield just 1.18%, which is barely higher than consumer price inflation for the past year.

The difference between regular Treasury yields and TIPS yields, often called the "breakeven inflation rate," is a rough measure of the market's inflation expectations for the future. That breakeven inflation rate has grown since the Fed made it clear it was going to restart its bond buying, an effort known as quantitative easing.

Paul Vigna discusses Monday's markets and why the yield for TIPS went negative for the first time ever.

In the case of five-year TIPS, the negative yield suggests inflation expectations of about 1.70%—hardly runaway inflation, but better than deflation.

The Fed's policy-setting committee said at its most recent policy meeting that inflation was below its desired level.

Investors sought 2.84 times the amount on sale. Anything more than two times oversubscribed is considered a success. Indirect bidders—domestic and foreign institutions, including foreign central banks—took a hefty 39% of the notes.

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